India’s inflation targeting framework, which was established through amendments to the RBI Act in 2016, established a statutory basis for managing inflation. This framework aimed for a target inflation rate of 4%, allowing a range of 2% to 6%, also known as flexible inflation targeting. As the policy approaches its ninth year of implementation, RBI’s inflation target and its approach to setting the repo rate will be up for review in March 2025.
Two distinct opinions have emerged ahead of this review: one from the Chief Economic Advisor (CEA) and another from the RBI Governor, each bringing their own perspective on how best to approach inflation control in the future. The latest Economic Survey has intensified this debate by proposing that food prices be excluded from the inflation targeting framework. The rationale is that food inflation is more influenced by supply-side factors rather than demand, making short-term monetary measures less effective and potentially counterproductive.
Core inflation has up until now for the entire calendar year remained within the range of 3% – 3.7% and it is only food inflation that has taken the headline CPI above 6%. A 10.87% spike in food prices caused India’s retail inflation to reach a 14-month high of 6.2% in October, whereas core inflation (which excludes food and fuel) rose to 3.7%, much within the target range of RBI. The CEA, V. Anantha Nageswaran, has argued that the recent increase in retail inflation is primarily driven by a few specific items. He pointed out that excluding tomatoes, onions, and potatoes (TOPs), as well as gold and silver, from the CPI calculation would show a much lower inflation rate of 4.2% in the month of October.
Finance Minister Nirmala Sitharaman and Commerce Minister Piyush Goyal have echoed the argument by proposing that interest rates should be more affordable with the latter believing that focusing on food inflation while considering rate cuts is flawed. The government is of the opinion that RBI should not focus solely on inflation, as changing interest rates can’t control food prices. This view, highlighted in the Annual Economic Survey of July 2024, emphasised that the RBI should not be tasked with managing factors it cannot influence, such as supply shortages due to crop failures. The CEA concluded that India should return to the pre-inflation targeting method, popularly known as the multi-indicator approach, as using short-term monetary tools to address supply constraints could prove to be counterproductive.
However, RBI Governer, Shaktikanta Das has made his stance unambiguously clear. He emphasised that food inflation accounts for around 46% of the headline inflation index. Time and again he has never failed to mention how food inflation heavily influences household inflation expectations, which are critical for the future trajectory of overall inflation in the economy.
Even as core inflation has shown a downward trend, Governor Das noted that though short term fluctuations in food prices can be ignored, persistent food inflation could lead to second-round effects, such as higher wages, which would then spill over into core inflation.
With almost 46% of the weightage comes from food inflation and food articles, choosing headline inflation as the nominal anchor for the national monetary policy and subsequently managing inflation expectations makes perfect economic sense. In developing countries like India, where a large portion of the population’s total expenditure is spent on food, these costs are closely connected to wages and labor market expenses through a chain of effects. This, in turn, influences inflation expectations, which ultimately contribute to overall inflation. It is also important for authorities to recognise that the general public often views inflation primarily in terms of food prices and persistent high food inflation can undermine inflation expectations and economic stability.
With the next MPC meeting scheduled between 4-6 of this month, it would not be surprising to see the RBI choosing to maintain its status quo of not changing its interest rate from the current 6.5% with the release of October’s inflation data. Governor Das, in his note during the last MPC meeting pointed out that the Indian economy cannot risk ‘another bout of inflation’ and that more substantial evidence is needed in regard to the inflation rates settling around the 4% target. This would be the 11th consecutive monetary policy ,for 22 months, on a trot, that the repo rate has been left unchanged.
All eyes are on this meeting as it is expected to be Governor Das’ final one before his present term ends on December 10, soon after the MPC meeting concludes. The newly formed committee, with three external members inducted in October, also adds an element of uncertainty. Additionally, the looming possibility of tariff hikes by the new Trump administration on imported goods, which could increase commodity prices globally, is expected to be a key agenda item. Market analysts predict that the earliest rate cuts may have to await the next MPC meeting in February 2025, with the RBI still maintaining a neutral policy stance.
